Many industry-leading companies such as Amazon and Nike have seen their valuations cut by 40% or more in less than a year. Growth-orientated investors may be down worse, as several leading growth stocks are down 70% or more from their highs.
When a portfolio is down by 50%, it needs to double just to break even. And if it’s down 75%, it has to quadruple just to break even. Climbing out of a hole that deep can seem impossible. But the stock market has a track record for rewarding patience paired with a sound investing approach. Here’s the simplest road to recovery if the bear market has taken a sledgehammer to your portfolio.
Falling in a hole
There’s a great quote from The West Wing by the fictional White House Chief of Staff Leo McGarry that I think applies well to bear markets:
This guy’s walking down a street when he falls in a hole. The walls are so steep he can’t get out. A doctor passes by, and the guy shouts up, “Hey you, can you help me out?” The doctor writes a prescription, throws it down in the hole and moves on. Then a priest comes along, and the guy shouts up, “Father, I’m down in this hole, can you help me out?” The priest writes out a prayer, throws it down in the hole and moves on. Then a friend walks by. “Hey Joe, it’s me, can you help me out?” And the friend jumps in the hole. Our guy says, “Are you stupid? Now we’re both down here.” The friend says, “Yeah, but I’ve been down here before, and I know the way out.”
When times are tough, it can be helpful to listen to what top investors are saying or have done throughout past downturns. Peter Lynch, Warren Buffett, and Cathie Wood may have completely different investing styles. And Wood and Buffett tend to take opposite sides on a given argument — whether it’s cryptocurrency or valuation. But all three investors take a long-term approach that aims to cut the noise of short-term movements and lets money compound over time.
Taking a long-term approach means not trying to predict where the market is headed in the next month or year. Lynch and Buffett are famous for admitting that they have no idea what is going to happen in the short term. Rather, their big bets are based on multi-year moves. They also get it wrong all the time. Lynch often said that an investor only must be right 60% of the time to do very well.
The stock market is an incredible growth engine that has averaged an 8% annual return over the long term. But that doesn’t mean everyone should be heavily invested in the stock market.
Because no one knows where the stock market is headed in the short term, it’s a bad idea to invest money that you’ll need for a major purchase within a few years. Or aggressively investing if you have a lot of debt. Or foregoing an emergency fund to free up cash to invest in the stock market.
One of the worst mistakes an investor can make is adding pressure on their stock portfolio. If you plan on making a down payment on a home in a year, then you’re going to feel the short-term gyrations in the stock market much more than someone who doesn’t plan on withdrawing from their equity portfolio for 10-plus years. Similarly, if an investor doesn’t have a diversified portfolio, then they are going to be much more vulnerable to a given sector or investment category like growth stocks compared to value stocks.
The simple road to recovery
Bear markets present amazing buying opportunities and can lead to life-changing wealth. But it’s a mistake to try to get rich in a bear market by aggressively buying dips in stocks you don’t understand.
However, bear markets are the perfect time to do deep dives into your favorite industries and find the companies you believe have the right technology, management, and business models to compound over time.
For investors looking for a lower-risk alternative, the simplest and most effective way to recover from a bear market is by sticking with industry-leading companies with positive cash flows that have a track record for enduring past downturns.
Although every past bear market has historically been an excellent buying opportunity, not all companies get through a bear market. Some lose market share or are pressured to take on debt that leaves them paddling upstream for years. However, the best companies have a habit of emerging stronger on the other side of a bear market because they have the cash to make strategic acquisitions when the market is weak and can absorb a few bad quarters or down years without derailing their business.
A lifelong lesson
By having the right mindset, not panicking, and positioning your portfolio for long-term growth, you can give yourself the tools necessary to get out of the hole. And one day, you can look back and help others find the way out too.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and Nike. The Motley Fool has a disclosure policy.